FRONTDOOR, INC. The following information should be read in conjunction with the audited consolidated financial statements and related notes thereto included in Item 8 of this Annual Report on Form 10-K. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs. The cautionary statements discussed in "Cautionary Statement Concerning Forward-Looking Statements" and elsewhere in this Annual Report on Form 10-K should be read as applying to all forward-looking statements wherever they appear in this Annual Report on Form 10-K. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those factors discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Cautionary Statement Concerning Forward-Looking Statements" and "Risk Factors" included in Item 1A of this Annual Report on Form 10-K. For a discussion of our results of operations for the year endedDecember 31, 2020 compared to the year endedDecember 31, 2019 , see " Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations " in Part II of our 2020 Annual Report on Form 10-K filed with theSEC onFebruary 23, 2021 , which specific discussion is incorporated herein by reference.
Overview
Frontdoor is the leading provider of home service plans inthe United States , as measured by revenue, and operates under theAmerican Home Shield , HSA,OneGuard and Landmark brands. Our customizable home service plans help customers protect and maintain their homes, typically their most valuable asset, from costly and unplanned breakdowns of essential home systems and appliances. Our home service plan customers usually subscribe to an annual service plan agreement that covers the repair or replacement of major components of more than 20 home systems and appliances, including electrical, plumbing, central HVAC systems, water heaters, refrigerators, dishwashers and ranges/ovens/cooktops, as well as optional coverages for electronics, pools, spas and pumps. Our operations also include our ProConnect on-demand home services business and Streem, a technology platform that uses augmented reality, computer vision and machine learning to, among other things, help home service professionals more quickly and accurately diagnose breakdowns and complete repairs. As ofDecember 31, 2021 , we had 2.2 million active home service plans across all 50 states and theDistrict of Columbia .
For the year ended
For the year endedDecember 31, 2021 , our total operating revenue included 69 percent of revenue derived from existing customer renewals, while 16 percent and 13 percent were derived from new home service plan sales made in conjunction with existing home resale transactions and direct-to-consumer sales, respectively, and three percent was derived from other revenue streams. For the year endedDecember 31, 2020 , our total operating revenue included 69 percent of revenue derived from existing customer renewals, while 18 percent and 12 percent were derived from new home service plan sales made in conjunction with existing home resale transactions and direct-to-consumer sales, respectively, and one percent was derived from other revenue streams.
The Spin-off
OnOctober 1, 2018 , Terminix completed the Spin-off.Frontdoor was formed as a wholly-owned subsidiary of Terminix onJanuary 2, 2018 for the purpose of holding the Separated Business in connection with the Spin-off. During 2018, Terminix contributed the Separated Business toFrontdoor . The Spin-off was completed by a pro rata distribution to Terminix's stockholders of approximately 80.2 percent of our common stock. Each holder of Terminix common stock received one share of our common stock for every two shares of Terminix common stock held at the close of business onSeptember 14, 2018 , the record date of the distribution. The Spin-off was completed pursuant to a separation and distribution agreement and other agreements with Terminix related to the Spin-off, including a transition services agreement, a tax matters agreement, an employee matters agreement and a stockholder and registration rights agreement. See Note 10 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for information related to these agreements to the extent they are still in effect. OnMarch 20, 2019 , Terminix agreed to transfer its remaining 16,734,092 shares ofFrontdoor stock to a financial institution pursuant to an exchange agreement. Subsequent to that date, the financial institution conducted a secondary offering of those shares. The transfer was completed onMarch 27, 2019 , resulting in the full separation ofFrontdoor from Terminix and the disposal of Terminix's entire ownership and voting interest inFrontdoor . 32 --------------------------------------------------------------------------------
Key Factors and Trends Affecting Our Results of Operations
Impact of the COVID-19 Pandemic
The implications of the COVID-19 pandemic on our results of operations and overall financial performance remain uncertain. In response to the COVID-19 pandemic, we have taken a number of steps to protect the well-being of our employees, customers and contractors, and we continue to respond to the real-time needs of our business. Specifically, we have:
Established a Cross-Functional Business Continuity Team. This core team actively monitors national and local developments and emerging issues, deploys coordinated and strategic real-time responses to address the needs of employees, customers and contractors, and ensures ongoing operational efficiency during this time. Changed How Employees Work. We fully transitioned all of our customer service agents to work remotely from their homes, ensuring uninterrupted customer service. The majority of our remaining workforce, including those at ourMemphis corporate headquarters and other locations, are also working remotely.Increased Customer Communications . Our contractor network was designated by theU.S. Department of Homeland Security as "Essential Critical Infrastructure Workers " during the COVID-19 response and has consistently been deemed "essential" by state and local governments. As of today, we do not foresee significant disruption to our ability to provide services to our customers. Nevertheless, we are managing customer responses on a case-by-case basis, and actions may vary by location. To address virus-related concerns and ensure that we are handling the most critical service requests first, we established a special COVID-19 response team, increased customer communication and implemented safety screening protocols during the service initiation and delivery process. Accelerated the Deployment of Streem's Augmented Reality Technology. In order to protect the health and safety of the public, including our customers, contractors and commercial partners, we accelerated the deployment of Streem's augmented reality remote video technology. Using this innovative solution, we are enabling contractors to engage remotely with customers to reduce the number of required in-person visits and speed the repair process. Increased Contractor Education and Communication. Because our contractor network provides essential services, it is generally operating normally despite varying state and local conditions. We are leveraging theCenters for Disease Control and Prevention ("CDC") recommendations to increase customer and technician screening for COVID-19 and remain in ongoing communication with contractors to enable them to operate withinCDC guidelines and help ensure the health and safety of their technicians, as well as our customers. To further these efforts, we introduced our Streem technology platform to our contractors at no cost during this time, enabling social distancing for customers and contractors through remote diagnostics and reduced in-person interactions to resolve customers' issues. Managing Supply Chain. We continue to experience global supply chain challenges, which has led to industry-wide price increases for parts and equipment as well as availability challenges across our trades as demand has outpaced production. We continue to see an elevated level of appliance service requests compared to pre-pandemic levels as customers spend more time at home in light of the COVID-19 pandemic. As a result, we have deepened and expanded our supplier relationships, improved access to appliances with the highest demand, increased speed of parts acquisition and expanded our service provider network. We continue to closely monitor the distribution of parts and replacement units and are working with our suppliers to increase availability to us. We believe our multi-vendor strategy will help mitigate these impacts on our business.
Financial Impact to our Business. During 2021, our financial condition and results of operations were adversely impacted by the COVID-19 pandemic as follows:
?The tight existing home sales market continued to constrain demand for home service plans in the first-year real estate channel. Additionally, due to the annual nature of our home service plan agreements and the corresponding recognition of revenue over this annual period, real estate revenue was adversely impacted by the decline inU.S. existing home sales that occurred in 2020. ?We continued to experience an increase in appliance claims compared to pre-pandemic levels primarily due to increased usage driven by customers spending greater time at home in response to COVID-19. Industry-wide parts availability challenges have caused increased cost pressure and have continued to drive elevated appliance replacement levels due to lack of parts availability, further contributing to the increased costs. In addition, during the second half of the year, we experienced rapid increases in contractor labor and contractor-supplied parts and equipment. These industry-wide challenges also impacted the customer experience, which was reflected in our customer retention rate. 33
-------------------------------------------------------------------------------- ?We incurred incremental customer service wages due to a higher number of service requests in the appliance trade compared to pre-pandemic levels, which was primarily a result of customers spending greater time at home in response to COVID-19. Additionally, due to labor availability challenges, we continued to experience workforce retention issues, including difficulties in hiring and retaining employees in customer service operations and throughout our business, and we believe our contractors are experiencing similar workforce challenges. Although the economy has improved since the initial outbreak of the pandemic, we are unable to predict the time required for a widespread sustainable economic recovery to take hold. Given the wide disparities in vaccination rates driven by continued vaccine hesitancy, combined with the emergence of COVID-19 variants and surges in COVID-19 cases, we expect that a significant number of people will continue to spend greater time at home, which may result in a continued increase in usage of home systems and appliances and demand for our services and a resulting increase in service-related costs. We also expect that industry-wide supply chain challenges will continue to contribute to increased costs and impact the customer experience, which may affect customer retention. Accordingly, the COVID-19 situation remains very fluid, and we continue to adjust our response in real time. It remains difficult to predict the overall impact the COVID-19 pandemic will have on our business.
Macroeconomic Conditions and Inflation
Macroeconomic conditions that may affect customer spending patterns, and thereby our results of operations, include home sales, consumer confidence and employment rates. The COVID-19 pandemic has increased economic uncertainty in these areas. We believe our ability to acquire customers through the direct-to-consumer channel helps to mitigate the effects of challenges in the real estate channel, while our nationwide presence limits the risk of poor economic conditions in any particular geography. Additionally, global supply chain challenges, ranging from raw material inflation to transportation delays and labor shortages, impact our costs and customer experience, and we continue to take actions to mitigate these impacts.
Seasonality
Our business is subject to seasonal fluctuations, which drives variations in our revenue, net income and Adjusted EBITDA for interim periods. Seasonal fluctuations are primarily driven by a higher number of central HVAC work orders in the summer months. In 2021, we continued to experience additional variations as the COVID-19 pandemic resulted in an elevated level of service requests in the appliance trade compared to pre-pandemic levels as our customers spent more time at home. In 2021, approximately 21 percent, 29 percent, 29 percent and 21 percent of our revenue, approximately 4 percent, 31 percent, 60 percent and 5 percent of our net income, and approximately 12 percent, 38 percent, 41 percent and 9 percent of our Adjusted EBITDA was recognized in the first, second, third and fourth quarters, respectively.
Effect of Weather Conditions
The demand for our services and our results of operations are affected by weather conditions. Extreme temperatures can lead to an increase in service requests related to home systems, particularly central HVAC systems, resulting in higher claim frequency and costs and lower profitability. Weather conditions that have a potentially favorable impact to our business include mild winters or summers, which can lead to lower home systems claim frequency. For example, unfavorable weather trends in the first quarter of 2021 as compared to 2020 negatively impacted contract claims costs, while favorable weather trends in the third quarter of 2021 as compared to 2020 favorably impact contract claims costs. While weather variations as described above may affect our business, major weather events and other similar Acts of God, such as hurricanes, flooding and tornadoes, typically do not increase our obligations to provide service. Generally, repairs associated with such isolated events are addressed by homeowners' and other forms of insurance as opposed to the home service plans that we offer.
Tariff and Import/Export Regulations
Changes inU.S. tariff and import/export regulations may impact the costs of parts, appliances and home systems. Import duties or restrictions on components and raw materials that are imposed, or the perception that they could occur, may materially and adversely affect our business by increasing our costs. For example, rising costs due to blanket tariffs on imported steel and aluminum could increase the costs of our parts, appliances and home systems.
Competition
We compete in theU.S. home service plan category and the broaderU.S. home services industry. The home service plan category is highly competitive. The principal methods of competition, and by which we differentiate ourselves from our competitors, are quality and speed of service, contract offerings, brand awareness and reputation, customer satisfaction, pricing and promotions, contractor network and referrals. ? 34 --------------------------------------------------------------------------------
Acquisition Activity
We anticipate that the highly fragmented nature of the home service plan category will continue to create strategic opportunities for acquisitions. Historically, we have used acquisitions to cost-effectively grow our customer base in high-growth geographies, and we intend to continue to do so. We may also explore opportunities to make strategic acquisitions that will expand our service offering in the broader home services industry. We have also used acquisitions to enhance our technological capabilities and geographic presence. In 2019, we acquired Streem to support the service experience for our customers, reduce costs and create potential new revenue opportunities across a variety of channels. We expect to use Streem's services in our core home service plan business and in ProConnect's on-demand business to deliver a superior service experience and reduce our costs.
Non-GAAP Financial Measures
To supplement our results presented in accordance withU.S. GAAP, we have disclosed non-GAAP financial measures that exclude or adjust certain items. We present within this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section the non-GAAP financial measures of Adjusted EBITDA and Free Cash Flow. See "Results of Operations-Adjusted EBITDA" for a reconciliation of net income to Adjusted EBITDA and "Liquidity and Capital Resources-Free Cash Flow" for a reconciliation of net cash provided from operating activities to Free Cash Flow, as well as "Key Business Metrics" for further discussion of Adjusted EBITDA and Free Cash Flow. Management uses Adjusted EBITDA and Adjusted EBITDA margin to facilitate operating performance comparisons from period to period. We believe these non-GAAP financial measures provide investors, analysts and other interested parties useful information to evaluate our business performance as they facilitate company-to-company operating performance comparisons. Management believes Free Cash Flow is useful as a supplemental measure of our liquidity. Management uses Free Cash Flow to facilitate company-to-company cash flow comparisons, which may vary from company to company for reasons unrelated to operating performance. While we believe these non-GAAP financial measures are useful in evaluating our business, they should be considered as supplemental in nature and are not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance withU.S. GAAP. In addition, these non-GAAP financial measures may not be the same as similarly entitled measures reported by other companies, limiting their usefulness as comparative measures.
Key Business Metrics
We focus on a variety of indicators and key operating and financial metrics to monitor the financial condition and performance of the continuing operations of our business. These metrics include: ?revenue, ?operating expenses, ?net income, ?earnings per share, ?Adjusted EBITDA, ?Adjusted EBITDA margin,
?net cash provided from operating activities,
?Free Cash Flow,
?growth in number of home service plans, and
?customer retention rate.
Revenue. The majority of our revenue is generated from annual home service plan agreements entered into with our customers. Home service plan contracts are typically one year in duration. We recognize revenue at the agreed upon contractual amount over time using the input method in proportion to the costs expected to be incurred in performing services under the contracts. Our revenue is primarily a function of the volume and pricing of the services provided to our customers, as well as the mix of services provided. Our revenue volume is impacted by new home service plan sales, customer retention and acquisitions. We derive substantially all of our revenue from customers inthe United States . Operating Expenses. In addition to changes in our revenue, our operating results are affected by, among other things, the level of our operating expenses. Our operating expenses primarily include contract claims costs and expenses associated with sales and marketing, customer service and general corporate overhead. A number of our operating expenses are subject to inflationary pressures, such as: salaries and wages, employee benefits and healthcare; contractor costs; parts, appliances and home systems costs; tariffs; insurance premiums; and various regulatory compliance costs. 35 -------------------------------------------------------------------------------- Net Income and Earnings Per Share. The presentation of net income and basic and diluted earnings per share provides measures of performance which are useful for investors, analysts and other interested parties in company-to-company operating performance comparisons. Basic earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period, increased to include the number of shares of common stock that would have been outstanding had potentially dilutive shares of common stock been issued. The dilutive effect of stock options, restricted stock units ("RSUs"), performance shares (which are contractual rights to receive a share of our common stock (or the cash equivalent thereof) upon the achievement, in whole or in part, of the applicable performance goals, pursuant to the terms of the Omnibus Plan and the award agreement) and restricted stock awards ("RSAs") are reflected in diluted earnings per share by applying the treasury stock method. Adjusted EBITDA and Adjusted EBITDA margin. We evaluate performance based primarily on Adjusted EBITDA, which is a financial measure not calculated in accordance withU.S. GAAP. We define Adjusted EBITDA as net income before: depreciation and amortization expense; restructuring charges; provision for income taxes; non-cash stock-based compensation expense; interest expense; loss on extinguishment of debt; and other non-operating expenses. We define "Adjusted EBITDA margin" as Adjusted EBITDA divided by revenue. We believe Adjusted EBITDA and Adjusted EBITDA margin are useful for investors, analysts and other interested parties as they facilitate company-to-company operating performance comparisons by excluding potential differences caused by variations in capital structures, taxation, the age and book depreciation of facilities and equipment, restructuring initiatives and equity-based, long-term incentive plans.
Net Cash Provided from Operating Activities and Free Cash Flow. We focus on
measures designed to monitor cash flow, including net cash provided from
operating activities and Free Cash Flow, which is a financial measure not
calculated in accordance with
Growth in Number of Home Service Plans and Customer Retention Rate. We report our growth in number of home service plans and customer retention rate in order to track the performance of our business. Home service plans represent our recurring customer base, which includes customers with active contracts for recurring services. Our customer retention rate is calculated as the ratio of ending home service plans to the sum of beginning home service plans, new home service plan sales and acquired accounts for the applicable period. These measures are presented on a rolling, 12-month basis in order to avoid seasonal anomalies.
Critical Accounting Policies and Estimates
This "Management's Discussion and Analysis of Financial Condition and Results of Operations" is based upon our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, which have been prepared in accordance withU.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to: revenue recognition; home service plan claims accruals; the valuation of property and equipment, goodwill and intangible assets; useful lives for depreciation and amortization expense; accruals for income tax liabilities and deferred tax accounts; stock-based compensation; and litigation. We base our estimates on historical experience and on various other factors and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
We believe the following accounting policies are most important to the portrayal of our financial condition and results of operations and require our most significant estimates and judgments.
Home Service Plan Claims Accruals
Home service plan claims costs are expensed as incurred. Accruals for home
service plan claims are made using internal actuarial projections, which are
based on current claims and historical claims experience. Accruals are
established based on estimates of the ultimate cost to settle claims. Home
service plan claims take approximately three months to settle, on average, and
substantially all claims are settled within six months of incurrence. The amount
of time required to settle a claim can vary based on a number of factors,
including whether a replacement is ultimately required. In addition to our
estimates, we engage a third-party actuary to perform an accrual analysis
utilizing generally accepted actuarial methods that incorporate cumulative
historical claims experience and information provided by us. We regularly review
our estimates of claims costs along with the third-party analysis and adjust our
estimates when appropriate. We believe the use of actuarial methods to account
for these liabilities provides a consistent and effective way to measure these
judgmental accruals. However, the use of any estimation technique in this area
is inherently sensitive given the magnitude of claims involved. Given the
current operating environment, which includes industry-wide parts and equipment
availability challenges and inflation, our ability to estimate the cost to
settle claims is further challenged. We believe our recorded obligations for
these expenses are consistently measured. Nevertheless, changes in claims costs
can materially affect the estimates for these liabilities.
36
--------------------------------------------------------------------------------We assess the impairment of goodwill and indefinite-lived intangible assets annually, or more often if events or changes in circumstances indicate that the carrying value may not be recoverable.Goodwill and indefinite-lived intangible assets are tested for impairment at the reporting unit level by first performing a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value. If the reporting unit does not pass the qualitative assessment, then the reporting unit's carrying value is compared to its fair value. The fair values of the reporting units are estimated using market and discounted cash flow approaches. The discounted cash flow approach uses expected future operating results. The market approach uses comparable company information to determine revenue and earnings multiples to value our reporting units. Failure to achieve these expected results or market multiples may cause a future impairment of goodwill at the reporting unit.Goodwill and indefinite-lived intangible assets are considered impaired if the carrying value of the reporting unit exceeds its fair value. We conducted our annual impairment tests of goodwill and trade names as ofOctober 1, 2021 and 2020. As ofDecember 31, 2021 , we do not believe there are any circumstances, including those related to COVID-19, that would indicate a potential impairment of our goodwill or indefinite-lived intangible assets. We will continue to monitor the macroeconomic impacts on our business in our ongoing evaluation of potential impairments. There were no goodwill or trade name impairment charges recorded during the years endedDecember 31, 2021 or 2020. See Note 4 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for information related to our goodwill and intangible assets.
Newly Issued Accounting Standards
New accounting rules and disclosure requirements can significantly impact our
reported results and the comparability of our financial statements. See Note 2
to the audited consolidated financial statements included in Item 8 of this
Annual Report on Form 10-K for further information on newly issued accounting
standards.
?
37
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Results of Operations for the Years Ended
Increase
Year Ended December 31, (Decrease) % of Revenue
2021 vs.
(In millions) 2021 2020 ?2020 2021 2020
Revenue $ 1,602 $ 1,474 9 % 100 % 100 %
Cost of services rendered 818 758 8 51 51
Gross Profit 784 716 10 49 49
Selling and administrative
expenses 511 467 9 32 32
Depreciation and
amortization expense 35 34 3 2 2
Restructuring charges 3 8 * - 1
Interest expense 39 57 (31) 2 4
Interest and net investment
(income) loss (1) 1 * - -
Loss on extinguishment of
debt 31 - * 2 -
Income before Income Taxes 168 149 13 10 10
Provision for income taxes 39 37 8 2 2
Net Income $ 128 $ 112 14 % 8 % 8 %
________________________________
* not meaningful Revenue We reported revenue of$1,602 million and$1,474 million for the years endedDecember 31, 2021 and 2020, respectively. Revenue by major customer acquisition channel is as follows: Year Ended December 31, Growth (In millions) 2021 2020 2021 vs. 2020 Renewals$ 1,103 $ 1,013 $ 90 9 % Real estate(1) 252 263 (11) (4) Direct-to-consumer(1) 201 183 18 10 Other 46 16 31 * Total revenue$ 1,602 $ 1,474 $ 128 9 %
_________________________________
* not meaningful
(1)First-year revenue only.
Revenue increased 9 percent for the year endedDecember 31, 2021 compared to the year endedDecember 31, 2020 , primarily driven by higher renewal revenue due to improved price realization and growth in the number of renewed home service plans. The decrease in real estate revenue primarily reflects a decline in the number of first-year real estate home service plans, offset, in part, by improved price realization. The number of real estate home service plans declined due to the historically challenging seller's market, driven, in part, by record low home inventory levels. The increase in direct-to-consumer revenue primarily reflects improved price realization, a mix shift to higher priced products and growth in the number of first-year direct-to-consumer home service plans, mostly driven by increased investments in marketing. The increase in other revenue was primarily driven by growth in ProConnect and Streem.
Number of home service plans, growth in number of home service plans and customer retention rate are presented below.
As of December 31,
(In millions) 2021 2020
Number of home service plans 2.21 2.25
(Reduction) growth in number of home service plans (2) % 4 %
Customer retention rate 74 % 76 %
The number of home service plans and customer retention rate as of December 31,
2021 were negatively impacted by a decline in the number of first-year real
estate home service plans, which was driven by the tight existing home sales
market, as well as the impact on customer experience of industry-wide supply
chain challenges.
38
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Cost of Services Rendered
We reported cost of services rendered of
(In millions) Year EndedDecember 31, 2020 $ 758 Impact of change in revenue 35 Contract claims costs 23 Other 2
Year Ended
The increase in contract claims costs reflects increased cost pressures across all trades due to industry-wide parts and equipment availability challenges and inflation, offset, in part, by lower service request incidence across all trades and process improvement benefits. Appliance parts availability challenges continued to drive elevated replacement levels, contributing to the increased cost pressures.
Selling and Administrative Expenses
For the years endedDecember 31, 2021 and 2020, we reported selling and administrative expenses of$511 million and$467 million , respectively, which comprised sales and marketing cost of$245 million and$225 million , respectively, customer service costs of$116 million and$114 million , respectively, and general and administrative expenses of$150 million and$127 million , respectively. The following table provides a summary of changes in selling and administrative expenses: (In millions) Year EndedDecember 31, 2020 $ 467 Sales and marketing costs 20 Customer service costs 1 Stock-based compensation expense 8 General and administrative costs 14 Year EndedDecember 31, 2021 $ 511 The increase in sales and marketing costs was primarily driven by increased investments to drive sales growth in the home service plan direct-to-consumer channel, ProConnect and Streem. General and administrative costs increased compared to prior year primarily due to increased personnel costs and investments in technology. Prior year general and administrative costs include incremental direct costs related to COVID-19 of$1 million .
Depreciation Expense
Depreciation expense was
Amortization Expense
Amortization expense was
Restructuring Charges
We incurred restructuring charges of
In 2021, restructuring charges comprised$1 million of accelerated depreciation of certain technology systems driven by efforts to enhance our technological capabilities and$1 million of severance and other costs. In 2020, restructuring charges comprised$3 million of lease termination costs and severance and other costs related to the decision to consolidate certain operations of Landmark with those ofOneGuard ,$3 million of severance costs related to the reorganization of certain sales and customer service operations and$2 million of accelerated depreciation related to the disposal of certain technology systems. As ofDecember 31, 2020 , these activities were substantially complete. 39
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Interest Expense
Interest expense was$39 million and$57 million for the years endedDecember 31, 2021 and 2020, respectively. The decrease was due to a decline in interest rates on the unhedged portion of our variable rate debt, primarily driven by theJune 17, 2021 refinancing of the Prior Credit Agreement, theFebruary 17, 2021 partial repayment of the Prior Term Loan Facility and theJune 17, 2021 redemption of the 2026 Notes.
Interest and Net Investment (Income) Loss
Interest and net investment (income) loss reflects income of$1 million for the year endedDecember 31, 2021 and a loss of$1 million for the years endedDecember 31, 2020 . For the year endedDecember 31, 2021 , amounts primarily comprised interest on our cash and cash equivalents balances. For the year endedDecember 31, 2020 , amounts primarily comprised a$3 million loss on investment, offset, in part, by interest on our cash and cash equivalents balances.
Loss on Extinguishment of Debt
Loss on extinguishment of debt was$31 million for the year endedDecember 31, 2021 . Amounts primarily relate to theJune 17, 2021 redemption of the remaining outstanding principal amounts of$534 million of the Prior Term Loan Facility and$350 million of the 2026 Notes and include a "make-whole" redemption premium of$21 million on the 2026 Notes and the write-off of$9 million of debt issuance costs and original issue discount. Additionally,$1 million relates to theFebruary 17, 2021 partial repayment of the Prior Term Loan Facility and includes the write-off of debt issuance costs and original issue discount. There were no such charges for the year endedDecember 31, 2021 .
Provision for Income Taxes
The effective tax rate on income was 23.4 percent and 24.5 percent for the years endedDecember 31, 2021 and 2020, respectively. The decrease in the effective tax rate for the year endedDecember 31, 2021 compared toDecember 31, 2020 is primarily due to income tax credits and excess tax benefits for share-based awards, offset, in part, by an increase in state income taxes.
Net Income
Net income was$128 million and$112 million for the years endedDecember 31, 2021 and 2020, respectively. The increase was driven by the aforementioned operating results, offset, in part, by an increase in the provision for income taxes. Adjusted EBITDA
Adjusted EBITDA was
(In millions) Year EndedDecember 31, 2020 $ 270 Impact of change in revenue 93 Contract claims costs (23) Sales and marketing costs (20) Customer service costs (1) General and administrative costs (15) Other (4) Year EndedDecember 31, 2021 $ 300 The increase in contract claims costs reflects increased cost pressures across all trades due to industry-wide parts and equipment availability challenges and inflation, offset, in part, by lower service request incidence across all trades and process improvement benefits. Appliance parts availability challenges continued to drive elevated replacement levels, contributing to the increased cost pressures. The increase in sales and marketing costs was primarily driven by increased investments to drive sales growth in the home service plan direct-to-consumer channel, ProConnect and Streem. General and administrative costs increased compared to prior year primarily due to increased personnel costs and investments in technology. Prior year general and administrative costs include incremental direct costs related to COVID-19 of$1 million . ? 40
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The following table reconciles net income, which we consider to be the most directly comparable U. S. GAAP financial measure, to Adjusted EBITDA.
Year Ended December 31,
(In millions) 2021 2020
Net Income $ 128 $ 112
Depreciation and amortization expense 35 34
Restructuring charges(1) 3 8
Provision for income taxes 39 37
Non-cash stock-based compensation expense(2) 25 17
Interest expense 39
57
Loss on extinguishment of debt 31
-
Other non-operating expenses(3) - 5 Adjusted EBITDA $ 300$ 270
_________________________________
(1)We exclude restructuring charges from Adjusted EBITDA because we believe they do not reflect our ongoing operations and because we believe doing so is useful to investors in aiding period-to-period comparability. (2)We exclude non-cash stock-based compensation expense from Adjusted EBITDA primarily because it is a non-cash expense and because it is not used by management to assess ongoing operational performance. We believe excluding this expense from Adjusted EBITDA is useful to investors in aiding period-to-period comparability. (3)Represents other non-operating expenses, including, for the year endedDecember 31, 2020 , (a) a loss on investment of$3 million , (b) incremental direct costs related to the COVID-19 pandemic of$1 million , which were temporary in nature and primarily related to incremental health and childcare benefits for our employees and hoteling costs related to our offshore business process outsourcers and (c) acquisition-related transaction costs of$1 million . We have excluded these non-operating expenses from Adjusted EBITDA because we believe they do not reflect our ongoing operations and because we believe doing so is useful to investors in aiding period-to-period comparability. ? 41
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Liquidity and Capital Resources
Liquidity
A substantial portion of our liquidity needs are due to debt service requirements on our indebtedness. The Credit Agreement contains covenants that limit or restrict our ability, including the ability of certain of our subsidiaries, to incur additional indebtedness, repurchase debt, incur liens, sell assets, make certain payments (including dividends) and enter into transactions with affiliates. As ofDecember 31, 2021 , we were in compliance with the covenants under the agreements that were in effect on such date. Based on current conditions, we do not believe the COVID-19 pandemic will affect our ongoing ability to meet the covenants in our debt instruments, including our Credit Agreement. Cash and cash equivalents totaled$262 million and$597 million as ofDecember 31, 2021 and 2020, respectively. Our cash and cash equivalents include balances associated with regulatory requirements in our business. See "-Limitations on Distributions and Dividends by Subsidiaries." As ofDecember 31, 2021 and 2020, the total net assets subject to these third-party restrictions was$175 million and$180 million , respectively. As ofDecember 31, 2021 , there were$2 million of letters of credit outstanding and$248 million of available borrowing capacity under the Revolving Credit Facility. The letters of credit are posted in lieu of cash to satisfy regulatory requirements in certain states in which we operate. Available liquidity was$336 million as ofDecember 31, 2021 , consisting of$88 million of cash not subject to third-party restrictions and$248 million of available borrowing capacity under the Revolving Credit Facility. We currently believe that cash generated from operations, our cash on hand and available borrowing capacity under the Revolving Credit Facility as ofDecember 31, 2021 will provide us with sufficient liquidity to meet our obligations I the short- and long-term. We closely monitor the performance of our investment portfolio. From time to time, we review the statutory reserve requirements to which our regulated entities are subject and any changes to such requirements. These reviews may result in identifying current reserve levels above or below minimum statutory reserve requirements, in which case we may adjust our reserves. The reviews may also identify opportunities to satisfy certain regulatory reserve requirements through alternate financial vehicles. We may, from time to time, repurchase or otherwise retire or extend our debt and/or take other steps to reduce our debt or otherwise improve our financial position, gross leverage, results of operations or cash flows. These actions may include open market debt repurchases, negotiated repurchases, other retirements of outstanding debt and/or opportunistic refinancing of debt. The amount of debt that may be repurchased or otherwise retired or refinanced, if any, and the price of such repurchases, retirements or refinancings will depend on market conditions, trading levels of our debt, our cash position, compliance with debt covenants and other considerations. OnFebruary 17, 2021 , we repaid$100 million of outstanding principal amount of the Prior Term Loan Facility. In connection with the repayment, we recorded a loss on extinguishment of debt of$1 million , which included the write-off of debt issuance costs and original issue discount. OnJune 17, 2021 , we entered into the Credit Agreement, providing for the Term Loan A maturingJune 17, 2026 , the Term Loan B maturingJune 17, 2028 and the Revolving Credit Facility, which terminatesJune 17, 2026 . The net proceeds of the transaction, together with cash on hand, were used to redeem the remaining outstanding principal amounts of$534 million of the Prior Term Loan Facility and$350 million of the 2026 Notes at a price of 106.1%. In addition, the Revolving Credit Facility replaced the Prior Revolving Credit Facility. In connection with the repayments, we recorded a loss on extinguishment of debt of$30 million in the second quarter of 2021, which included a "make-whole" redemption premium of$21 million on the 2026 Notes and the write-off of$9 million of debt issuance costs and original issue discount. See Note 13 to the consolidated financial statements included in Item 8 of this report for more information related to our indebtedness. OnSeptember 7, 2021 , we announced a three-year repurchase authorization of up to$400 million of outstanding shares of our common stock. We expect to fund the share repurchases from net cash provided from operating activities. As ofDecember 31, 2021 , we have purchased 2,560,844 outstanding shares at an aggregate cost of$103 million under this program, which is included in treasury stock on the consolidated statements of financial position. Purchases under the repurchase program may be made from time to time by the company in the open market at prevailing market prices (including through a Rule 10b5-1 Plan), in privately negotiated transactions, or through any combination of these methods, throughSeptember 3, 2024 . The actual timing, number, manner and value of any shares repurchased will depend on several factors, including the market price of the company's stock, general market and economic conditions, the company's liquidity requirements, applicable legal requirements and other business considerations. The repurchase program does not obligate us to acquire any number of shares in any specific period or at all and may be suspended or discontinued at any time at our discretion. ? 42
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Limitations on Distributions and Dividends by Subsidiaries
We depend on our subsidiaries to distribute funds to us so that we may pay obligations and expenses, including satisfying obligations with respect to indebtedness. The ability of our subsidiaries to make distributions and dividends to us depends on their operating results, cash requirements, financial condition and general business conditions, as well as restrictions under the laws of our subsidiaries' jurisdictions. Our subsidiaries are permitted under the terms of the Credit Agreement and other indebtedness to incur additional indebtedness that may restrict or prohibit the making of distributions, the payment of dividends or the making of loans by such subsidiaries to us. Furthermore, there are third-party restrictions on the ability of certain of our subsidiaries to transfer funds to us. These restrictions are related to regulatory requirements. The payments of ordinary and extraordinary dividends by certain of our subsidiaries (through which we conduct our business) are subject to significant regulatory restrictions under the laws and regulations of the states in which they operate. Among other things, such laws and regulations require certain subsidiaries to maintain minimum capital and net worth requirements and may limit the amount of ordinary and extraordinary dividends and other payments that these subsidiaries can pay to us. We expect that such limitations will be in effect for the foreseeable future. InTexas , we are relieved of the obligation to post 75 percent of our otherwise required reserves because we operate a captive insurer approved byTexas regulators in order to satisfy such obligations. None of our subsidiaries are obligated to make funds available to us through the payment of dividends.
Cash Flows
Cash flows from operating, investing and financing activities for the years
ended
Year Ended
December 31,
(In millions) 2021 2020
Net cash provided from (used for):
Operating activities $ 185 $ 207
Investing activities (31) (31)
Financing activities (489) (7)
Cash increase during the period
Operating Activities
Net cash provided from operating activities was
Net cash provided from operating activities in 2021 comprised$223 million in earnings adjusted for non-cash charges, offset, in part, by$38 million in cash used for working capital. Cash used for working capital was primarily driven by the impacts on deferred revenue of a decline in the number of first-year real-estate home service plans and a shift in the mix of annual-pay customers to monthly-pay customers. Net cash provided from operating activities in 2020 comprised$170 million in earnings adjusted for non-cash charges and$37 million in cash provided from working capital. Cash provided from working capital was primarily driven by an increase in amounts payable to contractors and suppliers, due, in part, to the timing of claims payments as a result of industry-wide availability challenges in the appliance trade, and the timing of trade payables.
Investing Activities
Net cash used for investing activities was
Capital expenditures were$31 million in 2021 and$32 million in 2020 and included recurring capital needs and technology projects. We expect capital expenditures for the full year 2022 relating to recurring capital needs and the continuation of investments in information systems and productivity enhancing technology to be approximately$40 million to$50 million . We have no additional material capital commitments at this time. ? 43
-------------------------------------------------------------------------------- Cash payments for business acquisitions, net of cash acquired, were$5 million in 2020. During the second quarter of 2020, we acquired a business to expand our ProConnect on-demand offering for$5 million in cash. There were no acquisitions in 2021. Cash flows provided from purchases, sales and maturities of securities, net, in 2020 were$7 million and were driven by the maturities of marketable securities. There were no cash flows provided from purchases, sales and maturities of securities in 2021.
Financing Activities
Net cash used for financing activities was
During the year endedDecember 31, 2021 , we borrowed$638 million , net of discount, under the Term Loan Facilities, made scheduled principal payments of debt and finance lease obligations of$10 million and redeemed the remaining outstanding principal amounts of$634 million of the Prior Term Loan Facility and$350 million of the 2026 Notes. In connection with the repayments, we paid a "make-whole" redemption premium of$21 million on the 2026 Notes and debt issuance costs of$8 million . In addition, we repurchased$103 million of common stock.
During the year ended
Free Cash Flow
The following table reconciles net cash provided from operating activities,
which we consider to be the most directly comparable
Year Ended December 31 ,
(In millions) 2021 2020
Net cash provided from operating activities $ 185$ 207 Property additions (31) (32) Free Cash Flow $ 154$ 175 Contractual Obligations The following table presents our contractual obligations and commitments as ofDecember 31, 2021 . Less than More than (In millions) Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years Principal repayments*$ 632 $ 17 $ 34 $ 222$ 359 Estimated interest payments(1) 112 24 47 29 12 Non-cancelable operating leases 29 5 8 5 12 Purchase obligations 18 11 6 1 - Home service plan claims* 88 88 - - - Total amount$ 879 $ 145 $ 94 $ 257$ 383
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* These items are reported in the audited consolidated statements of financial position included in Item 8 of this Annual Report on Form 10-K.
(1)These amounts represent future interest payments related to existing debt obligations based on interest rates and principal maturities specified in the associated debt agreements. As ofDecember 31, 2021 , payments related to the Term Loan Facility are based on applicable rates as ofDecember 31, 2021 plus the specified margin in the Credit Agreement for each period presented. As ofDecember 31, 2021 , the estimated debt balance (including finance leases) as of each fiscal year end from 2022 through 2026 is$615 million ,$598 million ,$581 million ,$564 million and$359 million , respectively, and the weighted-average interest rate on the estimated debt balances as of each fiscal year end from 2022 through 2026 is 3.9 percent, 3.9 percent, 4.0 percent, 2.2 percent and 2.4 percent, respectively. See Note 13 to the audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for the terms and maturities of existing debt obligations. 44 --------------------------------------------------------------------------------
Financial Position
The following discussion describes changes in our financial position from
?Cash and cash equivalents decreased during 2021, primarily due to payments of debt, net of borrowings, and repurchases of common stock, offset, in part, by cash provided from operating activities.
?Accounts payable increased during 2021, reflecting the timing of trade payables.
?Deferred revenue decreased during 2021, reflecting a decline in the number of first-year real estate home service plans and a shift in the mix of annual-pay customers to monthly-pay customers.
?Current portion of long-term debt increased during 2021, reflecting the refinancing of our debt.
?Long-term debt decreased during 2021, reflecting payments of debt, net of borrowings.
?Other long-term liabilities decreased during 2021, primarily due to the change in the valuation of our interest rate swap.
?Total shareholders' equity was a surplus of$2 million as ofDecember 31, 2021 compared to a deficit of$61 million as ofDecember 31, 2020 . The increase was primarily driven by the$128 million of net income generated in 2021, offset, in part, by repurchases of common stock. See the audited consolidated statements of changes in equity (deficit) included in Item 8 of this Annual Report on Form 10-K for further information. ? 45
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